Bypassing the rush for customs, the nation’s private equiteers boarded their Gulfstream jets and flew off to holidays on their private tropical islands. There, they drank cocktails on the beach, feasted on lavish buffets, and took refreshing swims in cerulean waters.

PEP’s July exit of KFC franchisee Collins Foods and its aftermath would make it harder for their PE firms to exit investments through IPOs, fundies warned.
Photo: Glenn Campbell

But these private equiteers didn’t reach such heights by switching off for too long. So, during their long summer siestas, their minds wandered back to the bustling CBDs of the deal economy, as they formulated eight resolutions for the new year. Here they are:

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George Roberts: ‘The key in business is to go where the puck is going, not to where it is.’
Photo: Reuters

Leaders of the industry have therefore been trying to cast PE in a more positive light.

This is important on several levels, including the ability to raise big funds, to convince boards to open their books for due diligence – and for general self-esteem.

So in 2012, I will dedicate myself to explaining more often, to whoever will listen,that what I do is justified, both morally and economically.

2. I will use leverage, but not too much

Historically, Australian domestic private equity has worked within relatively modest debt levels for acquisitions, especially when compared with the global giants of the leveraged buyout industry. Yet the global financial crisis, and more recently the withdrawal of some of Europe’s banks from local markets amid their own regional turmoil, has curtailed leverage levels.

But debt levels are slowly climbing back up. As measured by debt/EBITDA, industry watchers say the ratio is moving from an average of around 3 times in the depths of 2008, to between 4 and 5 times today (still well down on the 2009 peak of closer to 9 times). This is helping to increase return on equity.

But PE investors and target boards can increasingly cotton on to financial engineering. Some see high leverage as a mask covering up a lack of management ability. Large borrowings can also force up asset prices at the purchasing stage, hence reducing overall portfolio returns for highly levered funds.

So in 2012, I will continue to look for ways of increasing my borrowingsand limiting equity investment to enhance my returns, but I’ll be careful not to go too hard, too soon.

3. I will keep more skin in the game

Just when the scars of TPG’s Myer exit were starting to heal, PEP’s July exit of KFC franchisee
Collins Foods
turned in to an unmitigated disaster. As the stock plummeted after a profit warning three months after listing, fundies warned equiteers the saga would make it harder for their PE firms to exit investments through initial public offerings.

Local private equity managers have had 12 IPOs over the $US100 million mark in the past decade, according to Dealogic, and have kept skin in the game in four (
Goodman Fielder
,
Norfolk Group
,
Emeco Holdings
and
Bradken
). But these retained stakes have all been small (20 per cent or less).

So in 2012, to help support the aftermarket and help redress the stigma about PE floats, I will consider retaining more equity in companies should I float them.

4. I will continue to explore alternative exits

Despite the sorry state of IPO markets in 2011, it’s been a bumper year for PE exits – with almost $11 billion of assets being sold. While PEP’s $235 million exit of Collins Foods and Quadrant Private Equity’s $NZ130 million exit of Summerset Group were among the largest floats, the big money was made through trade and secondary sales.

Flagship trade sales included the $4 billion deal where KKR sold
Seven West
Media to WA Newspapers; PEP and Unitas’s $1.1 billion sale of Independent Liquor of Asahi; and Archer’s $630 million sale of Rebel Sport to Super Retail. Big secondaries included Archer’s $1.2 billion sale of MYOB to Bain Capital; and PEP’s $470 million sale of Tegel to Affinity.

Over the decade to 2011, 44 per cent of local PE exits have been via initial public offerings, 44 per cent by trade sale and 12 per cent by secondary sales, according to analysis by Deutsche Bank. So while IPOs were the dominant avenue for exit between 2003 to 2007, over a longer period, IPOs and trade sales are finely balanced. In the US, trade sales are the dominant exit route: Deutsche found over the past five years, trade sales have comprised 55 per cent of US PE exits; sales to other PE players make up 34 per cent, while IPOs represent just 11 per cent.

So in 2012, I will continue to pursue dual-track sales processes, and considerselling assets to my competitors, as way of overcoming risky public marketsand recalcitrant fund managers.

5. I will consider alternative ownership structures

When Unitas Capital, the private-equity owner of Exego Group, exited automotive brand Rep­co in October, it retained 70 per cent of the group (30 per cent was sold to US-based Genuine Parts Company for $US150 million). The deal illustrates an emerging trend in PE trade sales, which sits in contrast to the typical 100 per cent exits in public markets: private equity continuing to hold substantial stakes. Other examples include CHAMP keeping 25 per cent in Manassen Foods when it was sold to Bright Foods; and KKR maintaining 11 per cent of Seven West.

Alternatives to the 100 per cent leveraged buyout are also being considered for asset acquisitions. In November, PEP bought 50 per cent of toilet paper and tissue maker SCA Hygiene Australasia, as its Swedish parent, Svenska Cellulosa Akiebolaget, sought access to local expertise and the local capital market to support the company’s growth.

So in 2012, as I consider acquisitions and exits, I will continue to think outsidethe square regarding structuring, and may value influence over absolute control.

6. I will learn from the global masters

Globally, PE funds are estimated to have more than $US1 trillion of capital to deploy on investments. Despite relatively high domestic valuations and mature markets, the stability of Australia and its growth prospects makes it an attractive market for foreign players to dabble in.

According to Deutsche Bank numbers, international sponsors hold 73 per cent of the estimated value of private equity investments in Australia. They are also looking to tap local superannuation pools. For example, in late October, management from Boston-based Thomas H Lee Partners, with $US22 billion of funds under management, spent a week in Sydney and Melbourne to press the flesh with potential investors ahead of the raising of its next global fund in 2012. Its most recent fund, its sixth, raised $US8 billion, and the net return of its funds under management over 37 years has been 21 per cent per annum.

Local managers would also salivate over the average composite net internal rate of return for PE behemoth Kohlberg Kravis Roberts’s private equity funds, which has been 19.9 per cent a year. But realising you’ve got to keep nimble to excel, and realising the hot competition in global PE, KKR, along with other global players, are quickly entering new areas, including as distressed debt and mezzanine finance. The later has delivered an unleveraged rate of return of between 13 per cent and 16 per cent for KKR.

So in 2012 – to the extent my investment mandate allows it – I will look tonew pockets of the capital markets to exploit investment opportunities.

7. I will work harder to convince directors about value

While the Spotless board continues its reluctant dance with PEP over the later’s $2.68 per share offer, private equity typically struggles to convince local boards to engage with indicative offers (which are largely seen as attempts at to have targets force open their books for due diligence). Perhaps boards take PE’s interest as an indication they have under-delivered.

Yet the share price performance of companies that have rejected proposals from private equity suggest boards’ reluctance to engage has not always produced a good result for their own shareholders.

For example,
APN News & Media
is trading at 88 per cent below the offer that Carlyle Group and Providence put on the table in October 2006, while
Qantas
is trading 73 per cent below the PE offer made a month later. Meanwhile,
Perpetual
’s shares are down 50 per cent on the KKR offer of October last year. Shares in Boon Logistics, Tassal and Orica are all languishing well below recent PE offers.

So in 2012, as I mingle with directors, I will remind them that our offers arenot necessarily low-ball, and when they are assessing them, they really shouldkeep their shareholders in mind at all times.

These titles provided some insight into the ideas that shaped one of the most prominent investors in the world – and how high-end literature can craft thinking and PE strategy. Hamlet is essentially a play about the dangers of procrastination, a tale of an individual crippled by the fear of acting. Macbeth, on the other hand, is a play about greed – but one that carries a stern warning about the dangers of excessive ambition.

And, with 2012 shaping up as a big year of sport (the London Olympics, the debut of the Green Edge cycling team), Roberts observed that much can be learned about business from watching sport, and questioning sportsmen. He pointed to ice-hockey legend Wayne Gretzky, who once told Roberts he had become great because of an ability to anticipate. And so thinks Roberts.

“The key in business is to go where the puck is going, not to where it is," Roberts told the July breakfast. “To be able to anticipate how the world is changing, how your business is changing and what the tools are that you need to make changes is what separates companies that survive, grow, perpetuate and flourish from the ones that don’t."

So in 2012, I will get inspired by cultural feats, and seek to apply to my business the insight of sporting and literary champions.